An IRA is a savings account the government lets you use tax-free or tax-deferred to build retirement money

An Individual Retirement Account (IRA) is a container — a legal structure that holds money and investments — with special tax rules attached. You open it at a bank, brokerage, or credit union. You put money in. That money can sit in cash, or you can use it to buy stocks, bonds, mutual funds, or other investments. The account grows, and when you turn 59½, you can take the money out. The tax benefit is the point: depending on which type of IRA you choose, you either pay no tax on the growth, or you pay no tax when you put the money in.

An IRA is not an investment itself. It is not a fund you buy into. It is a legal wrapper around whatever you choose to hold inside it. The IRA rules say what you can put in, when you can take it out, and how the government taxes it. The investments inside follow their own rules. This separation matters because it means you control what the money buys — you are not locked into a single fund or strategy.

Key Takeaways

  • An IRA is a tax-advantaged account you open at a financial institution, and you decide what investments go inside it.
  • Traditional IRAs let you deduct contributions from your taxable income now, but you pay income tax on withdrawals in retirement.
  • Roth IRAs take after-tax money now, but withdrawals in retirement are tax-free, and you can withdraw contributions (not earnings) before 59½ without penalty.
  • You can contribute only if you have earned income, and contribution limits reset each year — currently $7,000 for those under 50 and $8,000 for those 50 and older.
  • Withdrawals before 59½ usually trigger a 10% penalty plus income tax, though some exceptions exist for hardship, first-time home purchase, or education costs.

Traditional IRA: Tax deduction now, taxes on withdrawal later

A Traditional IRA works like this: you contribute money, and if your income is below a certain threshold (or if you have no workplace retirement plan), you deduct that contribution from your taxable income for the year. That means if you earn $60,000 and contribute $7,000 to a Traditional IRA, you report only $53,000 as taxable income. You pay less tax that year.

The money grows inside the account — tax-free. You do not pay tax on dividends, interest, or capital gains while the money sits there. But when you withdraw money after 59½, you pay ordinary income tax on the full amount you take out. If you contributed $7,000 and it grew to $25,000, you pay income tax on all $25,000 when you withdraw it. The tax is deferred, not erased.

If you withdraw before 59½, you owe income tax on the withdrawal plus a 10% penalty — unless an exception applies. Common exceptions include withdrawals for a first-time home purchase (up to $10,000 lifetime), unreimbursed medical expenses, health insurance premiums while unemployed, or may have access to education costs. The IRS publishes the full list in Publication 590-B.

Roth IRA: No tax deduction now, tax-free withdrawals later

A Roth IRA reverses the tax timing. You contribute after-tax money — money you have already paid income tax on. You get no deduction. But the money grows tax-free, and when you withdraw it after 59½, you owe no tax on the growth or the original contributions.

The Roth has a major advantage for younger savers: you can withdraw your contributions (the money you put in, not the earnings) at any time, for any reason, with no tax or penalty. If you contributed $7,000 and it grew to $25,000, you can pull out the $7,000 anytime. You cannot touch the $18,000 in growth without penalty until 59½, but the contributions are yours to access. This flexibility makes a Roth useful as an emergency fund that also grows for retirement.

Roth contributions have income limits. If you earn above a certain amount, you cannot contribute to a Roth directly. The limits change yearly and depend on your filing status. For 2024, the limit phases out between $146,000 and $161,000 for single filers. If you exceed the limit, you can use a "backdoor Roth" strategy — contributing to a Traditional IRA and converting it to a Roth — but this has tax complications and requires careful planning.

Contribution limits and earned income requirements

You can contribute to an IRA only if you have earned income — wages from a job, self-employment income, or other compensation reported to the IRS. You cannot fund an IRA with investment returns, rental income, or money from a spouse's paycheck (though a spouse can open a spousal IRA if the working spouse has enough income).

The contribution limit is the same for Traditional and Roth IRAs, and it resets January 1 each year. For 2024, you can contribute up to $7,000 if you are under 50, or $8,000 if you are 50 or older. The extra $1,000 for those 50+ is called a catch-up contribution. These limits are set by law and change periodically — check the IRS website or your financial institution for the current year's limit.

You can contribute only up to the amount of earned income you had that year. If you earned $5,000, you can contribute at most $5,000, even if the legal limit is $7,000. If you are married and one spouse does not work, the working spouse can open a spousal IRA in the non-working spouse's name, as long as the working spouse's income is at least double the total contribution.

How money grows inside an IRA and what you can hold

Once money is in an IRA, it can sit as cash, or you can invest it. Most people invest because cash earns almost nothing. Common holdings include stocks, bonds, mutual funds, exchange-traded funds (ETFs), and certificates of deposit (CDs). Some IRAs allow real estate or precious metals, but this requires a self-directed IRA through a specialized custodian.

The growth is tax-free inside a Traditional IRA and tax-free inside a Roth IRA. If you buy a stock for $1,000 and it rises to $3,000, you owe no tax on that $2,000 gain while it sits in the IRA. If you sell it and buy something else, there is no capital gains tax. This tax shelter is the entire reason IRAs exist — it lets your money compound without the drag of annual taxes.

You do not have to pick one investment and hold it forever. You can buy and sell within the IRA as often as you want. You can move the account from one institution to another through a direct transfer (the institutions handle it) or a rollover (you receive a check and deposit it elsewhere within 60 days). Moving between institutions does not trigger taxes or penalties as long as you follow the rules.

Required minimum distributions and the age 73 rule

With a Traditional IRA, the government eventually wants its tax money. Starting at age 73 (as of 2023, raised from 72 under the SECURE 2.0 Act), you must withdraw a minimum amount each year, calculated by dividing your account balance by a life expectancy factor the IRS publishes. This is called a required minimum distribution (RMD). If you do not take it, the IRS charges a 25% penalty on the amount you should have withdrawn (reduced to 10% if you correct it within two years).

Roth IRAs have no RMD during your lifetime. You can leave the money untouched as long as you live. This makes a Roth better for people who do not need the money in retirement or who want to pass wealth to heirs. Your heirs will eventually have to withdraw the money, but the timeline is longer.

If you have both a Traditional IRA and a SEP-IRA or SIMPLE IRA (workplace plans), the RMD rules are more complex. The IRS treats them as separate accounts for some purposes and combined for others. A tax professional can help you calculate the correct amount.

Rollovers from workplace plans and the 60-day rule

When you leave a job, you can move money from a 401(k), 403(b), or other workplace retirement plan into an IRA. This is called a rollover. You have two ways to do it: a direct rollover (the plan administrator sends the money straight to the IRA custodian) or an indirect rollover (they send you a check, and you deposit it into an IRA within 60 days).

The 60-day window is strict. If you receive a check and do not deposit it within 60 days, the IRS treats it as a withdrawal. You owe income tax on the full amount and a 10% penalty if you are under 59½. You get only one indirect rollover per 12-month period across all your IRAs combined — if you do two in one year, the second one is taxed and penalized. A direct rollover avoids this risk entirely and is the safer choice.

When you roll over a Traditional 401(k) to a Traditional IRA, there are no taxes or penalties. When you roll over a Roth 401(k) to a Roth IRA, there are no taxes or penalties. But if you roll a Traditional plan into a Roth IRA, you owe income tax on the pre-tax money — this is a Roth conversion and requires careful planning.

Early withdrawal penalties and exceptions

Withdrawing before 59½ normally costs you 10% of the amount withdrawn, plus income tax. But the IRS recognizes certain hardships and allows penalty-free withdrawals. For a Traditional IRA, these include a first-time home purchase (up to $10,000 lifetime), unreimbursed medical expenses above 7.5% of adjusted gross income, health insurance premiums while unemployed, may have access to education costs, and distributions due to disability or medical hardship. A Roth IRA allows penalty-free withdrawal of contributions anytime, and earnings can be withdrawn penalty-free for the same hardship reasons.

The rules are detailed and the IRS interprets them narrowly. "First-time home buyer" means you have not owned a home in the past two years — not that you are buying your first house ever. "may have access to education costs" include tuition, fees, books, and room and board for the account owner or their children or grandchildren, but not student loan repayment. If you think an exception applies, read IRS Publication 590-B or consult a tax professional before withdrawing.

Frequently Asked Questions

Can I have both a Traditional IRA and a Roth IRA?

Yes. Your combined contributions to all IRAs cannot exceed the annual limit ($7,000 for those under 50 in 2024), but you can split that between accounts. Many people use both: a Roth for flexibility and tax-free growth, and a Traditional IRA for the immediate tax deduction. The choice depends on whether you expect higher or lower tax rates in retirement.

What happens to my IRA if I die?

Your beneficiary inherits the account. They can take the money out immediately and pay income tax on it, or they can stretch withdrawals over their lifetime (rules changed in 2020 and vary by beneficiary type). A spouse can treat the inherited IRA as their own. Non-spouse beneficiaries must withdraw everything within 10 years. Name a beneficiary when you open the account, and update it after major life changes.

Can I borrow from my IRA?

No. IRAs do not allow loans. You can withdraw money (and pay the tax and penalty if you are under 59½), but you cannot borrow and repay. Some workplace 401(k) plans do allow loans, which is one reason some people keep money in both an IRA and a workplace plan.

Do I need to file taxes if I only have IRA income?

It depends on the amount and type. If you have only Traditional IRA withdrawals and no other income, you must file if the withdrawal exceeds the standard deduction for your age and filing status. If you have a Roth IRA, may have access to withdrawals are not taxable income, so you may not need to file. Consult a tax professional or use the IRS interactive tool on their website.

What is the difference between an IRA and a 401(k)?

An IRA is individual; you open it yourself. A 401(k) is through your employer. A 401(k) usually has higher contribution limits ($23,500 for 2024) and may include employer matching. An IRA gives you more control over investments. Many people have both: they contribute to an employer 401(k) to get the match, then max out an IRA for additional tax-advantaged savings.